Edited version of private advice

Authorisation Number: 1052282304089

Date of advice: 29 July 2024

Ruling

Subject: CGT - retirement exemption

Question

Can You and your sibling choose to apply the small business retirement exemption in Subdivision 152-D of the Income Tax Assessment Act 1997 (ITAA 1997) to the gain arising from the sale of the commercial property?

Answer

No. The commercial property is not an active asset in accordance with Division 152 of the ITAA 1997 as you and your sibling did not use the commercial property in a business of your own or a business of an affiliate or an entity connected with you. As a result, the exception at paragraph 152-40(4)(e) will apply to exclude the commercial property from being regarded as an active asset as the main use of the commercial property is to derive rent. The commercial property is not considered to be an active asset and the small business concessions in Division 152 cannot be accessed in relation to the disposal of the commercial property.

This ruling applies for the following period:

Year ending 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You and your sibling obtained finance to purchase and invest in a commercial property.

The commercial property was leased to an unrelated party and the tenant had exclusive possession of the commercial property.

The commercial property was never used for any other purpose during the ownership period of 9 years.

In July 20XX the commercial property was sold for $X.X million.

You and your sibling satisfied the maximum net asset value test just before the CGT event occurred.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10(1)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 subsection 152-305(1)

Reasons for decision

Subsection 152-305(1) of the ITAA 1997 sets out the conditions that must be met to disregard all or part of a capital gain from a CGT asset. One of the conditions is that the basic conditions for relief in Subdivision 152-A are satisfied.

The basic conditions in Subdivision 152-A of the ITAA 1997 stipulates the CGT asset must satisfy the active asset test.

However, subsection 152-40(4) lists CGT assets that cannot be active assets that need to be considered.

Under paragraph 152-40(4)(e), an asset whose main use is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

If the main use of the property was to derive rent at any time, the property was not an active asset at that time.

Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? (TD 2006/78) considers the active asset test and the main use to derive rent concept. Paragraph 22 of TD 2006/78 states that:

Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as follows:

•         the amount payable by a tenant to a landlord for the use of the leased premises (C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62 at 76, 86, 93, 99);

•         a tenant's periodical payment to an owner or landlord for the use of land or premises (The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne); and

•         recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments. ....... The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let (Halsbury's Laws of England 4th Edition Reissue, Butterworths, London 1994, Vol 27(1) 'Landlord and Tenant',paragraph 212).

In addition, paragraph 23 states:

A key factor therefore in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession (Radaich v. Smith (1959) 101 CLR 209; Tingari Village North Pty Ltd v. Commissioner of Taxation [2010] AATA 233 at paragraphs 44-46, 2010 ATC 10-131, 78 ATR 693 and associated Decision Impact Statement 2008/4646 & 2008/4647). If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

Example 1 in TD 2006/78 considers if the main use is to derive rent and states:

Commercial Property Co owns 5 commercial rental properties. The properties have been leased for several years under formal lease agreements to various commercial tenants which have used them for office and warehouse purposes. The terms of the leases have ranged from 1 year to 3 years with a 3-year option and provide for exclusive possession. The company has not engaged a real estate agent to act on its behalf and manages the leasing of the properties itself.

In this situation, the company has derived rental income from the leasing of a number of properties. Accordingly, the main (only) use of the properties is to derive rent and they are therefore excluded from being active assets under paragraph 152-40(4)(e) of the ITAA 1997 regardless of whether the activities constitute the carrying on of a business.

Application to your circumstances

In your situation you and your sibling owned a commercial property that was leased to an unrelated third-party tenant granting them exclusive possession. Accordingly, the main (only) use of the commercial property is to derive rent and is therefore excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Consequently, as the commercial property does not satisfy the active asset test, you and your sibling do not satisfy the basic conditions in section 152-10 and Subdivision 152-A of the ITAA 1997 in respect of the capital gain made on the sale of the commercial property. Therefore, you and your sibling also do not satisfy the requirements in Subdivision 152-D and are not eligible to apply the retirement exemption.